The Washington Supreme Court’s Expedia Decision Is More Bad News on the Duty to Defend and Extrinsic Evidence Rule

In our inaugural April 11, 2014 blog entry, “The Elephant in the Room,” we expressed hope that Washington’s Supreme Court would adopt a more reasonable duty to defend rule. Most states allow insurers to rely on facts outside the “four” or “eight corners” of the complaint and policy (often called “extrinsic evidence”) if these facts don’t prejudice or affect the underlying defense. Unfortunately the Court dashed our hopes for a more reasonable extrinsic evidence rule with its July 3, 2014 decision in Expedia, Inc. v. Steadfast Ins. Co.

The Washington Duty to Defend Landscape

To review, Washington’s Supreme Court has forbidden insurers from looking outside the complaint despite several well recognized (at least outside Washington) exceptions to this “extrinsic evidence” rule. One problem with Washington forbidding insurers from relying on extrinsic evidence is that before Expedia, its Supreme Court never really held insurers could not do this. Rather, a dozen years ago, the Court offhandedly said insurers were not supposed to rely on extrinsic evidence in deciding if they have a duty to defend. But extrinsic evidence wasn’t at issue in the case now cited in support of Washington’s extrinsic evidence rule(Truck Ins. Exch. v. Vanport Homes, Inc.). Expedia provided the Court with an opportunity to adopt a narrow but well recognized exception that insurers may rely on extrinsic evidence if it does not prejudice the underlying defense.

Expedia Facts

The insureds in Expedia are online services which negotiate lower prices for hotel rooms and then sell these reservations to its customers at a discounted price. Local governments charge occupancy taxes for hotel rooms which the insured passes on to its customers and then reimburse the local governments. The insured charged the local occupancy tax at the cheaper rate the insured negotiated with the hotels. But the local governments sued the insured alleging it should have sought reimbursement of the occupancy tax based on the higher hotel room price the insured charged its customers.

The insured knew as early as 2002 that the local governments thought the insured was not charging enough for occupancy taxes. The insured told both its shareholders (in 2002) and the SEC (in 2003) of this problem. In late 2004, the first of numerous suits by local governments were filed alleging the insured should have charged more for occupancy taxes. But note that all these events predate the insurers’ policy periods, which began in 2005.

The Bad News

As we described in our April 11, 2014 blog entry, the insurers’ attorney crystalized a classic insurance principle, the known loss rule, as “you can’t buy insurance on a burning building.” Yet here the insured violated the known loss rule by seeking coverage for liability it knew about before its policy started. The insurers relied on a 2002 case from the Washington Supreme Court in which it affirmed denial of defense tenders when the insured knew about the pollution for which it was being sued. Overton v. Consolidated Ins. Co.

So it would seem that the Court would recognize that it approved of the known loss rule and clarify Washington law on the duty to defend in allowing insurers to rely on extrinsic evidence if it does not prejudice the underlying case. Not so. Perhaps the most disappointing part of Expedia is how the Court downplayed its own prior recognition of the known loss rule in Overton. Instead the Court mechanically repeated insurers could not look outside the complaints’ allegations when evaluating their duty to defend. Again, the case cited for this proposition, Vanport Homes, didn’t concern extrinsic evidence. So under correct legal reasoning, Vanport Homes shouldn’t be cited to argue that insurers can’t consider extrinsic evidence. Unfortunately, the Court concluded, with little supporting analysis, that insurers may not consider evidence outside the complaint in deciding if they have a duty to defend.

Where We Go From Here

With the Expedia case, Washington insurers must avert their gaze from anything other than the complaint and the policy to decide if they have a duty to defend. This case places Washington outside the mainstream by not allowing any reasonable exceptions to the extrinsic evidence rule.